Don’t Take the Annuity

So let us suppose, reader, that you have won Wednesday’s $1.5 billion Powerball jackpot. Congratulations! You have some important decisions to make, such as what ailing magazine to acquire and what congressional seat your spouse should run for. But first, you must choose whether to take the prize as an annuity paid over 30 years, or a lump-sum payment right now.

There are several gaping flaws in the logic here. If you win the Powerball, don’t take the annuity. There are several reasons. First, as the Times correctly notes, if you take the cash option, you pay tax on that now, and then on future returns, whereas if you take the annuity, you only pay on future returns. The problem here is that if tax brackets do not change, those are economically equivalent. And in the worse case, there’s no reason to believe tax policy won’t change. Despite some protestations to the contrary, marginal tax rates on the highest brackets will go up over the next decade and if you’ve taken the annuity, you’re stuck paying a higher marginal tax rate and a higher real tax rate.

Second, the “ultrasafe” investment strategy espoused by the Times is to put the money into Treasuries. That’s exactly what the lottery will do, and you’ll get exactly the same return. Even a slightly diversified investment strategy will beat that over the long term. Put it into an S&P index fund and you’ll do better than Donal Trump.

Finally, there’s no reason to believe the state will hold up its end of the deal. Illinois has suspended payments to lottery winners. Illinois, Puerto Rico on Lake Michigan, has been unable to pass a budget and has stopped payments to lottery winners. Illinois’s debt problems may be severe, but they are not unique and it is not hard to imagine a state raiding a billion dollar trust fund for convenience’s sake. It happens all the time with retirement trusts.

So there you have it. Don’t take the annuity. And don’t listen to the Times.